|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||||||||||||||||||||
 
|
Board of DirectorsThe board of directors is the focal point of corporate governance. Directors represent the shareholders, and they are charged with safeguarding investors' interests. Historically, the election of directors was considered to be a routine matter, and incumbent directors routinely won re-election regardless of company performance. However, one could argue that electing the right candidate for director goes a long way toward ensuring that the corporation's governance policies are shareholder-friendly. Furthermore, while shareholder votes are held once a year, company directors oversee management and represent shareholder interests on an ongoing basis. Therefore, voting on directors and board-related issues is the most important use of the shareholder franchise, and not simply a routine proxy item. Although uncontested director elections do not present alternative nominees from whom to choose, a high percentage of withhold votes is an expression of shareholder dissatisfaction and should be sufficient to elicit a meaningful response from management. Directors should provide corporate leadership but refrain from interfering in day-to-day company operations that are properly the province of the chief executive officer (CEO) and other senior executive officers. The board must hold executives accountable for their actions. The effectiveness of the board is a direct function of its composition and structure. ISS supports strong boards that demonstrate a commitment to creating shareholder value. While director candidates and other board-related issues must be evaluated on a case-by-case basis, giving consideration to the company's performance and total governance structure, ISS prefers to see mechanisms that promote independence, accountability, responsiveness, and competence. Independence: Without independence from management, the board may be unwilling or unable to effectively set company strategy and scrutinize performance or executive compensation. Accountability: Directors must be accountable to shareholders. Policies that promote accountability would include annual elections and shareholders' ability to fill vacancies or to remove directors without cause. These policies facilitate change in control of a company through a proxy contest, thus reducing the opportunity for management entrenchment. In addition, shareholders should not be limited to removing directors only for cause because that is a standard that is extremely difficult to meet; it permits removal of directors only if found (through due process) guilty of self-dealing, fraud, or misappropriation of company assets. It does not provide for removal of directors due to poor performance or poor attendance. Responsiveness: Directors should be responsive to shareholders, particularly in regard to shareholder proposals that receive a majority vote and to tender offers where a majority of shares are tendered. Furthermore, shareholders should expect directors to devote sufficient resources to oversight of a company. Competence: Companies should seek directors who can add value to the board through specific skills or expertise. However, election of directors should be on a case-by-case basis and not constrained by arbitrary limits such as age or term limits. Voting on Director Nominees in Uncontested ElectionsVote CASE-by-CASE on director nominees. VOTE WITHHOLD/AGAINST[1] individual directors who:
VOTE WITHHOLD/AGAINST the entire board of directors, (except new nominees, who should be considered on a CASE-by-CASE basis) if:
VOTE WITHHOLD/AGAINST Inside Directors and Affiliated Outside Directors (per the Classification of Directors below) when:
VOTE WITHHOLD/AGAINST the members of the Audit Committee if:
VOTE WITHHOLD/AGAINST the members of the Compensation Committee if:
VOTE WITHHOLD/AGAINST directors, individually or the entire board, for problematic governance issues or failure to replace management as appropriate. Discussion: Importance of Director ElectionsElecting directors is the most important stock ownership right that shareholders can exercise. By electing directors who represent their interests, shareholders can help to define performance standards against which management can be held accountable. But in practice, these "elections" rarely involve a choice. In most cases, the option given to shareholders is blanket endorsement of a slate of management nominees. In most proxy elections, this is not a problem. The vast majority of corporate directors fulfill their fiduciary obligations extremely well, and in most cases management's nominees should be supported. However, when available information demonstrates a poor performance record for specific nominees, shareholders should withhold votes from those candidates. The following factors should be considered in evaluating individuals who are proposed on an uncontested basis for election as director:
Other factors that may be appropriate to review include:
The following is an in-depth discussion of each factor to consider in deciding how to vote in uncontested elections, as well as a discussion of additional factors to consider in reviewing more significant votes, such as in a contested election. Criteria Reviewed in Selecting DirectorsDirector IndependenceDirectors with ties to management may be perceived to be less willing and able to effectively evaluate and scrutinize company strategy and performance. Additionally, boards without adequate independence from management may suffer from conflicts of interest and impaired judgment in their decision-making. Such was evidenced in 2001 and 2002 when a spate of accounting scandals, corporate bankruptcies, and executive malfeasance cost investors billions of dollars. In response, the self-regulatory organizations (SROs)--the New York Stock Exchange (NYSE) and NASDAQ--toughened their standards for board independence in November 2003 to promote better oversight of management. (AMEX has adopted standards that substantially mirror NASDAQ's). These include both a stronger definition of "independent" director and a requirement that a majority of the board be independent. In addition to fully independent audit committees, the NYSE requires listed companies to have separate compensation and nominating/governance committees composed solely of independent directors. NASDAQ only requires that the compensation and nominating functions be performed either by fully independent committees or by a majority of the independent directors. Both of the SROs mandate that the outside directors periodically meet in executive session without management present (the NYSE recommends at least once a year, and NASDAQ recommends at least twice a year). With these minimum standards--long urged by governance advocates--codified in the listing rules, shareholders can be expected to raise the bar of "best practices" for board independence. Many institutions and even members of the corporate community, such as the Business Roundtable, National Association of Corporate Directors (NACD), and a blue ribbon panel of the Conference Board, now advocate that a substantial majority of directors be independent. A two-thirds threshold has become commonplace in shareholder proposals, though in the eyes of most investors, the more independent the board, the better. One area of ongoing debate concerns the definition of director "independence." There are countless definitions of director independence that have been established by various corporate governance experts, organizations, and companies. These definitions vary from any director who is not an officer of the company to a director whose only link to the board is his board seat. ISS classifies directors into three categories: independent outside directors, affiliated outside directors, and inside directors. The NYSE and NASDAQ independence standards state that a director will only be deemed independent if the board affirmatively attests that he or she has no relationship with the company that would interfere with the director's exercise of independent judgment or in carrying out the responsibilities of a director. Nevertheless, certain types of relationships will preclude an independent finding by the board: directors (or those with family members) who are former employees of the company or its auditor; have commercial, advisory or, in the case of NASDAQ, charitable ties with the company; or have interlocking compensation committees. Such relationships also carry a three-year cooling-off, or look-back, period beginning on the date the relationship ends. ISS applies a stricter standard that carries a five-year cooling-off period for former executives, excluding former CEOs. In their final rules, both SROs established materiality standards for determining if relationships involving payments for products or services between the company and an organization for which the director (or his or her family member) is an executive officer, partner, or controlling shareholder is significant enough to compromise independence. NASDAQ will deem a director to be non-independent if the value of the transaction (both for-profit and non-profit) exceeds the greater of $200,000 or five percent of the recipient's revenue during a year. The NYSE, on the other hand, applies a one-way, rather than two-way, dollar test for such relationships: the transaction must be the greater of $1 million or 2 percent of the other company's gross revenues in a given year to disqualify the director as independent. Direct advisory relationships also face dollar tests under the SRO rules. The director of a NASDAQ company would not be independent if the director or a family member receives annual payments from the company exceeding $60,000, other than for board and committee service and from benefits plans. For the NYSE, the triggering amount is $100,000. The NYSE rules apply to “immediate family members,” defined as spouses, parents, children, siblings, in-laws, and persons sharing a home other than domestic staff. NASDAQ rules apply to “family members,” defined as spouses, parents, children, and siblings (whether by blood, marriage or adoption) or anyone residing in the person's home. ISS uses the term “Relative” in its policies, which follows the SEC’s new definition of “immediate family members,” which covers spouses, parents, children, step-parents, step-children, siblings, in-laws, and any person (other than a tenant or employee) sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company. The NYSE and NASDAQ define “company” to include any parent or subsidiary in a consolidated group with the company. Similarly, ISS, in its definition of company “affiliates” includes subsidiaries, sibling companies, and parent companies in a consolidated group. The NYSE and NASDAQ define an interlock as a director who is employed as an executive of another entity where any of the company's executives serve on the entity's compensation committee. ISS uses the SEC definition which includes: (a) executive officers serving as directors on each other's compensation or similar committees (or, in the absence of such a committee, on the board); or (b), executive officers sitting on each other's boards and at least one serves on the other's compensation or similar committee (or, in the absence of such a committee, on the board). An inside director is a director who also serves as an employee of the company. This fact alone means that inside directors cannot possibly fulfill one of their primary obligations: to oversee and evaluate management on behalf of shareholders. In other words, one cannot be objective when evaluating oneself. An officer of the company who is neither an employee nor classified as among the five most highly compensated individuals is not considered to be an inside director. Depending on his or her other relationships with the company, if any, the individual would be classified as either affiliated or independent. Directors who have beneficial ownership of more than 50 percent of the company's voting power are also defined as inside directors. This may be aggregated if voting power is distributed among more than one member of a defined group, e.g., members of a family beneficially own less than 50 percent individually, but combined own more than 50 percent. ISS does not advocate that no inside directors sit on boards. The CEO and other senior officers have more company knowledge and experience than anyone on the board. Without their presence, boards could not fulfill another primary obligation: to establish long-term, overall business strategy. However, shareholders clearly need a different kind of director to act as a watchdog over management, inside directors included. A perceived abdication of responsibility by independent corporate directors is one of the strongest rationales for shareholder participation in corporate governance. In this sense, shareholder participation in corporate governance serves not just to give shareholders a say in major governance decisions, but also to apply pressure on the independent directors to have them fulfill their duties to shareholders. Situated between inside and independent directors are affiliated outsiders--directors who are not employees of the company, or who do not beneficially own more than 50 percent of the company's voting power, but who, because of a family or business relationship with the company, cannot be assumed to be truly independent in judgment. Business Relationships SEC Regulation S-K does not prohibit business relationships by directors that may be considered conflicts of interest. It does, however, require that such relationships be disclosed so that potential investors may determine if there is a conflict; and if so whether the conflict will affect their decision to invest in certain companies. New SEC disclosure requirements for related-person transactions increase the threshold for disclosure from $60,000 to $120,000. The provisions of Regulation S-K dealing with potential conflicts that must be disclosed involve transactions between the company and directors and executive officers, business relationships between the company and other companies with which executive officers and directors are affiliated, and certain family relationships that may create a conflict. Additionally, the SEC has adopted a director compensation table that will disclose all compensation paid to each director, including all consulting fees. Among other things, companies must disclose all perquisites and personal benefits exceeding $10,000. ISS uses the NASDAQ materiality standard in determining if commercial and charitable relationships between directors and their companies (such as suppliers, creditors, or customers) are significant enough to qualify that director as an affiliated outsider. ISS believes that the NASDAQ test has broader applicability than NYSE's, since NASDAQ-listed companies range in size from micro-cap to large-cap. With respect to professional services, ISS will deem a director affiliated if he currently provides (or a relative provides) professional services directly to the company, to an affiliate of the company or an individual officer of the company or one of its affiliates in excess of $10,000 per year. Director’s Relative Employed by the Company With respect to family relationships, if a director is a relative of a current Section 16 officer of company or its affiliates; or is a relative of a current employee of company or its affiliates where additional factors raise concern (which may include, but are not limited to, the following: a director related to numerous employees; the company or its affiliates employ relatives of numerous board members; or a non-Section 16 officer in a key strategic role), the director will be deemed an affiliated outsider. Independent Outside Directors Independent outside directors are defined as individuals having no material connection to the company other than their board seat. Even if a director has served on the board for more than 10 years, he or she is still considered to be independent; however, the ISS analysis will indicate the year that each director joined the board. Table 2-1. ISS Categorization of Directors
Empirical Evidence: Importance of Board IndependenceAcademic studies and other sources of information suggest that corporate boards are aware of the need for board independence and are examining ways to improve the efficacy of boards of directors, focusing on the special roles of the chairman of the board and independent directors. Various studies have been conducted on the benefits of board independence, and most have found at least preliminary evidence that board independence is desirable. Some of these studies are listed below: A survey for Russell Reynolds Associates found that institutional investors are taking a closer look at the composition of boards. More than half of the survey participants stated that family ties on the board and boards with dismissed CEOs or other dismissed executives raise red flags. Other warnings include director interlocks and board members serving on multiple boards. Kenneth Scott and Allan Kleindon, in their article, "CEO Performance, Board Types and Board Performance: A First Cut," examined monitoring behavior by outsiders on a board of directors. They found preliminary evidence to support the theory that outside directors make better monitors of management than do insiders. The study focused on whether or not the board makes good CEO replacement decisions. Research by James Cotter, Anil Shivdasani, and Marc Zenner (detailed in "Do Independent Directors Enhance Target Shareholder Wealth During Tender Offers?") found that tender offer targets with at least a majority of independent directors realized approximately 20 percent higher average stock price returns than companies without a majority of independent directors. In their article, "An Investigation of the Relationship between Board Composition and Stockholder Suits" (published in the Strategic Management Journal), Idalene Kesner and Ray Johnson examined derivative suits filed in Delaware between 1975 and 1986. They found that insider-dominated boards were more likely to be sued for breach of their fiduciary duties than boards with a majority of outside directors. However, the study did not find a significant correlation between board composition and the outcome of the suits. Nonetheless, voting policies should not be based solely on board composition. Research on this subject has not conclusively determined an optimal board structure that makes sense for all companies. There are many examples of inside and affiliated directors, whether CEO selected or otherwise, who have impeccably discharged their fiduciary responsibility to owners, and no suggestion to the contrary is made here. As a general policy, however, shareholders should encourage companies to select directors whose principal commercial and personal connection to the company will not interfere with their fiduciary obligation to shareholders. The key issue is performance: While the ratio of inside to outside directors is an indicator of accountability, the actions taken by the board are proof of it. Where corporate performance has been poor and there are few independent directors on the full board, placing more independent directors on the board may be an appropriate first step toward improving company performance. Board Composition and CommitteesMost corporate governance experts agree that the key board committees (audit, compensation, and nominating/corporate governance) of a company should include only independent directors. The independence of key board committees has been encouraged by regulation. For example, SEC proxy rules require disclosure of any members of a compensation committee who have significant business relationships with the company or interlocking directorships. Similarly, the NYSE and NASDAQ have extended their independence requirements beyond audit committees to compensation and nominating panels. (NASDAQ does not require separate compensation and nominating committees, but only that a majority of independent directors perform those functions). For NYSE companies, all such panels must have written charters, published on the companies' websites. NASDAQ only requires audit committee charters; the nominating process may either be addressed in a formal written charter or by board resolution. April Klein, in her article "Firm Productivity and Board Committee Structure" (published by the Stern School of Business), found linkage between the composition of the board of directors and firm productivity by examining the committee structures of boards for firms listed on the S&P 500. Four major results were presented:
Given the importance of monitoring by the audit, compensation, and nominating committees, an investor should consider withholding votes for any insider or affiliated outsider on those committees. Nominating Committees As a matter of best practice as advocated by business groups, and the growing importance of nominating committee functions, companies should (1) have a formal nominating committee established and (2) only the independent board members should serve on this committee. Establishing a formal nominating committee composed of independent directors would ensure further accountability to shareholders in that the roles and responsibilities for the nominating process would be clearly defined in the company’s respective charter and guidelines. ISS will continue to recommend withhold votes from insiders and affiliated outsiders for failure to establish a formal nominating committee. However, as a clarification, this policy applies in cases in which the company has not established a nominating committee but the board attests that the independent directors serve the functions of such a committee. In addition, ISS will note in the report the issuer’s alternative to a lack of nominating committee, if any. Attendance at Board MeetingsCustomarily, boards set schedules for routine board and committee meetings at least a year in advance. Anyone who accepts a nomination to serve as director should be prepared to make attendance at scheduled meetings a top priority. Attendance information is summarized in every proxy statement where directors have attended less than 75 percent of board and committee meetings. Inquiries should be made regarding any director who attends less than 75 percent of these meetings. Directors who do not attend their board and committee meetings cannot be effective representatives of shareholders. When examining why a particular director failed to attend 75 percent of board and committee meetings, consider how many meetings were actually missed. For example, if the board held only two meetings during the year and a director missed one meeting, or 50 percent of the total meetings, do not necessarily withhold votes from this director unless a pattern of absenteeism had persisted for several years. However, unless there is a very good reason for missing meetings, absenteeism is generally sufficient cause to withhold votes from that director. Directors' Investment in the CompanyRequiring directors to own company stock serves to align the interests of directors with those of shareholders, for whom they act as a fiduciary. This is a concept that enjoys widespread support from both institutional investors and companies. While ISS does not advocate any specific required investment level, as this could effectively restrict board membership to the independently wealthy, shareholders should expect directors to invest at least some portion of their director compensation in the stock of companies of which they are directors within a year of election to the board. For a more complete discussion of directors' investment in the company, please refer to the "Stock Ownership Requirements" section. Corporate Governance Provisions and Takeover ActivityUnder state law, the board has the power to adopt a number of significant corporate governance items without shareholder approval, including “poison pills,” golden parachutes, and employee stock ownership plans. The board also has authority to decide the fate of the company in many takeover situations. While shareholder approval is required before certain charter amendments may be adopted, the board authorizes and recommends these amendments, which, given the nature of the proxy system, is tantamount to adoption. Directors must be held accountable for all of these decisions. It is therefore important for shareholders to assess the degree to which directors have included or excluded company owners in the governance process, specifically in terms of adopting charter and bylaw amendments that contribute to either an open or closed corporate governance structure. The following situations indicate a lack of responsiveness to shareholders and may warrant withhold/against votes from directors:
In applying withhold/against votes for problematic actions, shareholders should consider which directors to hold responsible. Clearly, new nominees who are being appointed to the board for the first time should be segregated from the incumbents when assigning “withhold” or “against” votes. Indeed, new board nominees may benefit a recalcitrant board if they show a greater willingness to heed the wishes of shareholders. Under such circumstances, ISS will exempt a new director from a “withhold” or “against” vote recommendation if he or she is just joining the board at the annual meeting or, in the case of an annually elected board, if the director joined the board since the last annual meeting. The term of the punishment must also be considered. The adoption of a lethal protective device like a dead-hand poison pill or its variants is unjustifiable from a governance standpoint. Because it is an ongoing detriment to shareholders--and one that was unilaterally adopted by the directors--votes should be withheld from or cast against board members until they remove the dead-hand provision. Adoption of a poison pill without shareholder approval, however, while undesirable is relatively less onerous than a dead-hand poison pill or its variants. Majority-supported proposals represent a request for action (usually the removal of an anti-takeover mechanism) by shareholder proponents. Because they are non-binding or precatory in nature, boards may easily disregard them, forcing proponents to either repeat their submissions, take alternative actions, or withdraw their offer altogether. For shareholders, the decision to continue withholding votes or applying “against” votes in years that the proposal is not resubmitted should be determined on a case-by-case basis. Such a decision should be based on whether the proponents and other shareholders have abandoned the matter or are maintaining pressure on the company, via a dialogue, a "vote no" campaign, or some other manner of engagement. Section 404 of the Sarbanes-Oxley Act Section 404 of the Sarbanes-Oxley Act requires that companies document and assess the effectiveness of their internal financial reporting controls. Companies with significant material weaknesses identified in the Section 404 disclosures potentially have ineffective internal controls, which may lead to inaccurate financial statements, hampering shareholders' ability to make informed investment decisions, and may lead to the destruction in public confidence and shareholder value. The audit committee is ultimately responsible for the integrity and reliability of the company's financial information, and its system of internal controls and should be held accountable. For companies that have problematic accounting practices, ISS will provide additional content and information in its analyses so that investors can make informed voting decisions. In cases such as: fraud; misapplication of GAAP; and material weaknesses identified in Section 404 disclosures, ISS may hold auditors and audit committee members accountable by recommending a withhold/against vote on audit committee members and against the ratification of the auditors. ISS may utilize the forensic accounting research produced by RiskMetrics’ Financial Research & Analysis staff and include their accounting insights in proxy reports for key meetings. Corporate Performance RecordBoards should be accountable to shareholders for the company's financial performance. More than ever, institutional shareholders use their voting rights in uncontested director elections to influence company performance. When determining whether to support management's slate of director nominees, shareholders should evaluate the company's long-term financial performance record based at a minimum on the following financial criteria:
The difficulty in this approach is defining performance and selecting meaningful measures. In line with their responsibilities to shareholders, boards attempt to view performance from the shareholders' point of view and therefore use stock price or some other performance indicator that is believed to influence stock price, such as change in earnings per share or return on equity. Using return on equity (ROE) defined as net income divided by average shareholder equity), as an example, if shareholders expect higher returns on their capital than indicated by the company's target ROE, then achieving the target is unlikely to favorably affect share price. In addition, ROE can be easily manipulated by leveraging a company or through a share repurchase program. It is estimated that at least 75 percent of public companies tie their executive incentive plans to increases in net income or earnings per share. Furthermore, there is a substantial amount of research on the effect of board structure and composition on corporate financial performance, most of it using accounting yardsticks that use earnings in a ratio to some balance sheet measure, such as return on equity, return on investment, profit margin on sales, and earnings per share. The problem with each of these measures is that an objective or goal can be achieved without necessarily increasing shareholder wealth or improving the company's long-term performance. This is true for several reasons, such as manipulative short-term actions or accounting gimmicks, which may achieve target accounting measures without fooling the market. Laudable accounting-based performance might be reached without increasing stock price for a number of reasons. However, while there seems to be a strong desire among institutional investors for factoring in corporate performance criteria in uncontested director elections, judging corporate performance solely by stock price measurements appears inadequate. A number of economic factors outside the control of management and the board can significantly impact a company’s stock price. Nonetheless, investors do believe total shareholder return is an important component in evaluating corporate performance. Five-year Total Shareholder Return (TSR) is consistently viewed as an appropriate time frame. In addition to this market-based measure, ISS’ methodology also incorporates three operational metrics in the analysis which include sales growth, EBITDA growth (or operating income growth for companies in the financial sector), and pre-tax operating Return on Invested Capital (ROIC) (or return on average assets (ROAA) for companies in the financial sector) on a relative basis within each four-digit GICS group. The three operational metrics chosen in the methodology effectively take into account factors that can be controlled by the company and which measure management effectiveness in utilizing capital and managing growth. The four metrics chosen for the methodology are supported by a majority of institutional investors. Furthermore, extensive feedback from both institutional investors and corporate issuers suggests the methodology should not hinge too much on the short-term. As such, the methodology places more weight on long-term operational and stock price performance measured over a five-year period. The methodology evaluates companies using a combination of four performance measures. One measurement will be a market-based performance metric and three measurements will be tied to the company’s operational performance. The market performance metric in the methodology is five-year TSR on a relative basis within each four-digit GICS group. The three operational performance metrics are sales growth, EBITDA growth, and (ROIC) on a relative basis within each four-digit GICS group. All four metrics will be time-weighted as follows: 40 percent on the trailing 12-month period and 60 percent on the 48-month period prior to the trailing 12 months. This methodology emphasizes the company’s historical performance over a five-year period yet also accounts for near-term changes in a company’s performance. The table below summarizes the new framework:
In applying the policy, ISS’ two-phased approach is as follows: In 2008 (Year 1), the worst performers (bottom 5 percent) within each of the 24 GICS groups will be noted in the ISS analysis. For 2009 (Year 2), if a company continues to be in the bottom 5 percent within its GICS group for that respective year and shows no improvement in its most recent trailing 12 months operating and market performance on an aggregate basis, ISS will evaluate the company’s overall performance relative to its peers on a case-by-case basis. This policy would be applied on a rolling basis going forward. ISS notes that the Year 2 test gives underperforming companies an opportunity to demonstrate near-term improvement in their performance. For companies which have already received cautionary language in 2007 and continue to be in the bottom 5 percent within their GICS group in 2008 and show no improvement in their most recent trailing 12 months operating and market performance on an aggregate basis (per the Year 2 test), ISS will evaluate the company’s overall performance on a case-by-case basis. ISS’ two-phased approach identifies the worst performers within each of the GICS groups. However, ISS evaluates corporate performance on a case-by-case basis taking into account the company’s situational circumstances including, but not limited to, changes in the board or management and year-to-date total shareholder returns. Further, corporate performance is considered in connection with the company’s overall governance practices in determining vote recommendations for director nominees. Separating Chairman & CEO RolesThe positions of chairman and CEO are two distinct jobs with different job responsibilities. The chairman is the leader of the board, which is responsible for selecting and replacing the CEO, setting executive pay, providing advice and counsel to top management, monitoring and evaluating managerial and company performance, and representing shareholder interests. By contrast, the CEO is responsible for managing the day-to-day operations of the company, acting as the company's spokesperson, and formulating strategy for the company, subject to the board's approval. Whether these positions should be separated is a matter of debate, although ISS generally favors such a separation. Board Membership of Retired CEOsAs shareholder attention focuses more on the board of directors, it is natural that certain nominees, by virtue of having served as the CEO of the company, require close scrutiny. Retired CEOs bring with them knowledge of the company, personnel, and industry that is hard to match. On the other hand, those very advantages could limit the new CEO's efficacy or could force the retired CEO to be an ineffective director. In short, it is a “Catch-22” for both the retired CEO and for shareholders. CEOs can represent the symbol of success (or failure) in business. Shareholders could assume that the directors who nominated an ex-CEO are knowledgeable about his qualifications. However, institutional shareholders cannot abdicate their ownership responsibilities, which include making an informed voting decision on every director candidate, the retired CEO included. For most boards, the question of whether to nominate the outgoing CEO is left to the new CEO. If he wants the retired CEO to remain as a director, few directors would challenge that decision. If the new CEO decides against such a nomination, the "dismissal" is handled diplomatically, generally by the board nominating committee. But the critical point is that the choice is up to the new CEO: he gets to choose the directors who presumably will oversee his own actions. One argument against retired CEOs remaining on the board is that they could dominate the board agenda and decisions. This relates to the fact that many, if not all, inside directors may owe their jobs to the retiring CEO and would be reluctant to contradict his views out of a sense of loyalty. The same can be said for non-executive directors who had been recruited by the retiring CEO. The presence of a retired CEO on the board could thus limit the new CEO's ability to assume the control he must have in order to be an effective leader. If the new CEO were a protege of the retiring CEO, there could be a conflict of interest; the new CEO would be torn by a sense of loyalty and a desire to follow his or her own agenda when the retiring CEO disagreed with a policy decision. If the new CEO was brought in from the outside, he or she could be blocked from effecting any major changes not approved by the retiring CEO. It would not be appropriate to apply a blanket veto to every retired CEO nominated for board membership. Therefore, shareholders should carefully consider several factors that could justify supporting the election of a retired CEO:
The special circumstances described above will certainly come into play at many companies. But there also will be cases when shareholders are so dissatisfied with corporate management that they will want to effect a meaningful change. In that case, withholding a vote for the retired CEO is a viable option. Board Decisions on Executive CompensationBoard decisions on executive compensation represent one of the sharpest conflicts of interest a board faces. Since many directors are recruited by management, there is a tendency for boards to provide management with lucrative pay packages in order to secure their board seats. Shareholders, on the other hand, see executive compensation packages as a key tool of corporate accountability. They want their boards to create executive compensation policies that have a strong correlation with shareholder returns and company and executive performance. Director CompensationA related question is how the company compensates its outside directors. Traditionally, director compensation has been composed of annual cash retainers, meeting fees, and committee fees. In the late 1980s and early 1990s, liability insurance, life insurance, travel insurance, retirement benefits, and other benefits were often added to director compensation packages. Because of the critical role played by the outside director, shareholder interests and share value may suffer if the outside director's compensation depends too much on staying in good graces with management. In addition, there is a legitimate question as to just how much, and what kinds of compensation devices, are justified for outside directors. Companies have encountered some backlash from investors, particularly regarding retirement plans for directors, and many such plans have been eliminated. Many investors believe that at least a portion of director compensation should be in stock to better align the director's interests with those of shareholders. Number of Other Board Seats or Over-BoardingIn the wake of new laws requiring directors to be even more engaged in protecting shareholder interests or else risk civil and/or criminal sanctions, board members are having to devote more time and effort to their oversight duties. In view of the increasing time commitments to be an effective director, governance experts have raised concerns about directors being overextended and “over-boarded.” Much of the academic work suggests that multiple board memberships can be advantageous, recognizing that directors with successful track records of board service, measured by firm performance, will be in high demand. But the question remains as to how many board seats are too many. Other studies, as well as director surveys and the National Association of Corporate Directors (NACD), maintain that directors are "busy" if they are employed full time and serve on more than three or four boards (two outside directorships for CEOs) or if they are retired and sit on more than six boards. The market also tends to react negatively when a company announces the appointment of a director that is a full-time executive at another firm and holds three or more board seats. In view of the increased demands placed on board members, directors who are overextended may be jeopardizing their ability to serve as effective representatives of shareholders. Even if a person were retired and devoted himself or herself full time to directorships, based on a full-time work schedule (1,920 hours per year) and the estimated hours of board service (300 per year), an individual could not reasonably be expected to serve on more than six boards. Accordingly, ISS will recommend that shareholders WITHOLD votes from directors who sit on more than six public company boards. Service on boards of subsidiary companies, private companies, or non-profit organizations will be excluded. If a director sits on several mutual fund boards within the same fund family, it will count as one board. Directors with full-time jobs have even less time to devote to outside board directorships. Although CEOs benefit from their exposure to other boards, this must be balanced against the time that is taken away from their primary responsibilities to their own companies. Both will suffer if a CEO is over-committed. Therefore, ISS will recommend that shareholders withhold votes from CEOs of public companies who serve on more than two public company boards besides their own company's board (in other words, more than three public company boards in total). Interlocking DirectorshipsAnother item to examine is "interlocks." Directors are said to be interlocked, for example, when the CEO of company A serves as a director of company B, and the CEO of company B serves as a director of company A. This is the simplest interlock; other variations are possible. SEC Regulation S-K requires disclosure of interlocks where executive officers serve as directors on each other's compensation or similar committees (or, in the absence of such a committee, on the board), and executive officers sitting on each other's boards and at least one serves on the other's compensation or similar committees (or on the board if there is no such committee). The issue for shareholders is simple: Objectivity may get lost amid the personal relationship shared by the interlocking directors, and shareholder interests may suffer. There is a large body of research that shows that interlocking directorships have a positive effect on company performance. The value added by interlocks appears to come from coordination of business activities, reduced transaction costs, and improved access to vital resources and information. However, if an interlocking directorship exposes a company to antitrust liability, or if there is clear evidence of self-dealing, shareholders should be concerned. One particular relationship that should raise a red flag is when the CEO of company A sits on the compensation committee of company B whose CEO is a director of company A or the converse. ISS typically categorizes such directors as affiliated outsiders. SummaryThe evolution of fiduciary shareholder requirements with regard to proxy voting, and the vast powers allotted the board of directors by the U.S. legal system, dictates that fiduciary shareholders make a reasonable effort to examine the performance record of director nominees at the companies on whose boards they serve. While in many instances voting decisions for directors should be made on a CASE-BY-CASE basis, there are some actions by directors that should result in AGAINST votes, or votes being WITHHELD. Below is a summary of ISS’ policy on voting for directors: VOTE WITHHOLD/AGAINST individual directors who:
VOTE WITHHOLD/AGAINST the entire board of directors, (except new nominees, who should be considered on a CASE-BY-CASE basis) if:
VOTE WITHHOLD/AGAINST Inside Directors and Affiliated Outside Directors (per the Classification of Directors below) when:
VOTE WITHHOLD/AGAINST the members of the Audit Committee if:
VOTE WITHHOLD/AGAINST the members of the Compensation Committee if:
VOTE WITHHOLD/AGAINST directors, individually or the entire board, for problematic governance issues or failure to replace management as appropriate. Notes
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||